What are the reasons for a stock dividend instead of a cash dividend?
A corporation might declare a stock dividend instead of a cash dividend in order to 1) increase the number of shares of stock outstanding, 2) move some of its retained earnings to paid-in capital, and 3) minimize distributing the corporation's cash to its stockholders.
If a corporation has 100,000 shares of stock outstanding and it declares a 10% stock dividend, the corporation ends up having 110,000 shares outstanding. An individual stockholder having 1,000 shares prior to the 10% stock dividend will have 1,100 shares after the stock dividend. This individual's stake in the corporation was 1% (1,000 out of 100,000 shares) prior to the stock dividend and will remain at 1% (1,100 out of 110,000 shares) after the stock dividend.
Since the corporation hasn't really changed because of the stock dividend, the total market value of the corporation should not change. In other words, if the total market value of the corporation was $1 million before the stock dividend, it should be $1 million after the stock dividend. However, the market value of each share should decrease: $1,000,000 divided by 100,000 shares = $10 per share, and $1,000,000 divided by 110,000 shares = $9.0909. The total market value of the individual's holdings should also remain the same: 1,000 shares X $10 = $10,000, and 1,100 shares X $9.0909 = $10,000. If the market does not adjust for the increased number of shares, the individual stockholders will benefit.
